Handout_01

Chapter 1: Thinking Like an Economist

1. The Scarcity Principle

• Scarcity Principle (No Free-Lunch Principle):

  • Having more of one good means having less of another; resources are limited.

  • Scarcity of resources necessitates choices, emphasizing the importance of economics: the study of choices and results under scarcity.

2. The Cost-Benefit Principle

• Cost-Benefit Principle:

  • Take an action if and only if the extra benefits are at least as great as the extra costs.

• Marginal Analysis:

  • Marginal Benefits vs. Marginal Costs.

• Example: Should you study one extra hour per day for your economics class?

3. Economic Surplus and Opportunity Cost

• Economic Surplus:

  • The benefit of an action minus its costs.

  • Formula: Economic Surplus = Total Benefits - Total Costs.

• Opportunity Cost:

  • The value of what must be forgone to undertake an activity, encompassing both explicit and implicit costs.

  • Opportunity cost considers only the best alternative.

  • Example: Opportunity cost of going to the movies (sum of explicit + implicit costs).

4. The Incentive Principle

• Incentive Principle:

  • People and firms respond to incentives.

  • Positive Incentives (Carrots):

    • Rewards for desirable behavior.

  • Punitive Incentives (Sticks):

    • Penalties for undesirable behavior.

Decision-Making and Cost-Benefit Analysis

1. Cost-Benefit Analysis and Better Decision-Making

• Scenario 1: Buying a $20 alarm clock when Walmart sells the same clock for $10.

• Scenario 2: Considering a $2,510 laptop at campus versus a $2,500 price at Walmart.

2. Three Decision Pitfalls in Reasoning

Pitfall #1: Measuring Costs and Benefits

• Mistakenly measuring as proportions instead of absolute amounts.

• Key focus on Marginal Costs vs. Marginal Benefits.

Pitfall #2: Ignoring Relevant Costs

• Usually involves overlooking implicit costs; leads to underestimating total costs.

  • Distinction between Explicit Costs and Implicit Costs, focusing again on Opportunity Cost.

Pitfall #3: Failure to Think at the Margin

• Sunk costs cannot be recovered and should not influence current decisions.

• Example: Asking yourself, "Should I eat another slice of pizza?"

3. Marginal Analysis Example: NASA Space Shuttle

• Cost Data:

  • 0 Launches: Total Cost = $0

  • 1 Launch: Total Cost = $3B

  • 2 Launches: Total Cost = $7B

  • 3 Launches: Total Cost = $12B

  • 4 Launches: Total Cost = $20B

  • 5 Launches: Total Cost = $32B

• Marginal Benefit Consideration:

  • If the marginal benefit is $6 billion per launch, determine how many launches NASA should make.

  • Average Cost Calculation: Explore average and marginal costs across different launches.

Normative and Positive Economic Analysis

• Normative Economic Statements:

  • Opinions on how people should behave.

  • Example: "Gas prices are too high."

• Positive Economic Statements:

  • Descriptive claims that can be tested for truth.

  • Example: "The average price of gasoline in Seattle is $3.30."